Last month, office retailer Staples reported disappointing quarterly results that caused the market to trounce the stock 15% the following day. While the average investment analyst expected the company to earn $0.22 per share for the quarter, the chain reported only $0.18 per share as ink and paper sales slowed, thus missing Wall Street’s target by almost 20%. What further spooked investors was management’s decision to lower its sales guidance for the upcoming year from high single digit growth to mere stagnancy.
Despite the disappointment, there are several identifiable catalysts that will move the stock higher.
Improving US Employment Situation
First, the company’s stock performance is correlated to the US payroll data released on the first Friday of every month. So far in 2012, the job gains have surpassed analyst estimates half the time (January, February, March, and August) while disappointing the other half (April, May, June, July). In the week following positive US jobs data that surpassed estimates, SPLS has gained an average 2.86% (best gain being 6.31% the week following August 3 when 163,000 jobs were created the prior month, surpassing the 100,000 estimate). In the week following disappointing US jobs data that missed estimates, SPLS lost an average 3.37% (worst loss being -5.54% the week following June 1 when only 69,000 jobs were added, far less than the 150,000 expected).
As the US economy continues to improve, additional jobs will be created. Not only will November’s Presidential election present greater certainty for cautious employers on the future regulatory environment, but it also seems evident that the troubled housing market bottomed earlier this year. As Americans see the value of their homes appreciate and the wealth effect that goes along with it, greater confidence will return to the system. Along with confidence come the animal spirits needed for a free enterprise system to flourish.
Second, the strongest catalyst favoured by all value investors alike is a cheap valuation. Over time, stock prices converge with their underlying value. Today, SPLS trades at 8x next year’s earnings, representing a 50% discount to its historic forward multiple. Compare that to Amazon, a competitor, which trades at a stunning 322x next year’s earnings.
Cash Flow Generation
Third, the company generates a substantial volume of cash flow. With this liquidity, the company is not only buying back $500M worth of shares annually but the stock also offers a 4% dividend yield to investors. Because the dividend represents only 1/5 of its cash flow from operations, the payout is clearly sustainable and could increase if the board desired. Over the next five years, analysts expect the company to use its cash and buy 20% of the shares currently outstanding today.
Overall, while today’s price is obviously a more attractive entry point than earlier in the year, investors that buy undervalued stocks with the patience to allow their investment thesis to materialize will ultimately be rewarded for owning SPLS.
*Disclosure: clients of Baskin Financial Services Inc. are shareholders of SPLS.